Recently, DWT payments team members Vincent Wang and Norm Page sat down in our Shanghai office to discuss recent developments involving China Union Pay (CUP). Vincent Wang has extensive experience helping U.S. companies and other clients pursue, develop and maintain operations in China, and he advises clients in a wide range of areas, including payments, e-commerce, and intellectual property matters. Norm Page focuses on domestic and international business transactions and works with Internet and e-commerce clients on commercial and financial matters, including credit programs with Internet payment companies.

The following is a recap of their conversation.

Norm Page (NP): Last year, CUP was the subject of a WTO dispute regarding its de facto monopoly position in the processing of transactions effected with RMB-based cards. Recently, CUP was reported to have been involved in another effort to leverage its market power. What are the details?

Vincent Wang (VW): This time it’s the Chinese licensed non-financial institution payment processors, rather than the international card networks, who have a problem with CUP. To really understand what’s happening, you have to start with the other lead actor in the story, Alipay. Last March, Alipay publicly announced that it would invest 500 million RMB in establishing its brand-new COD business. Alipay intended to target the service at logistics companies and small and micro e-commerce merchants. It planned to distribute Alipay-branded POS terminals that integrated bank-card payment functionality with delivery-information management functionality. The selling point was a real-time match of payments and logistic information. It was an ambitious plan.

Recently, however, Alipay made another public announcement—the company is abandoning the plan.

NP: Why, after such a large investment and such a short time period, would Alipay abandon its plan?

VW: Alipay released a statement on August 27, 2013, indicating that “Due to a reason that is publicly well known, Alipay will stop all of its offline POS business. We will properly deal with the merchants that use our offline POS service and will make sure that their normal business will not be impacted. We sincerely apologize for the inconvenience thus caused to our customers and business partners. However, we will never stop in our exploration of innovative payments solutions.”

NP: What is this “publicly well-known reason,” and why couldn’t Alipay spell it out in its announcement?

VW: Here’s where CUP enters the story. The so-called “publicly well-known reason” is CUP’s request that third-party payment processors must connect with CUP’s bankcard network system in order to process bank cards with a CUP logo. The third-party payment processors think that this requirement is another effort by CUP to leverage its monopoly status, and that it’s unfair to the payment processing business and the customers.

NP: CUP is not a regulatory agency in China, so CUP’s request doesn’t have binding force on the third-party payment processors. Why does Alipay care about it, to the extent of closing down a major initiative?

VW: CUP doesn’t have any administrative power over the third-party processors, but it did initiate a three-step plan. First, CUP sent a letter to all the banks entitled “Standardize the Business Cooperation with Non-Financial Institution Payment Processors on CUP Cards.” The point of the letter was to scare the banks about the risks of cooperating with non-financial institution payment processors. The letter suggested that (1) the banks should clean up their existing direct portal connections with the non-financial institution payment processors, and (2) the bank headquarters reserve the right to open new portal connections with the non-financial institution payment processors only at the headquarters level. CUP’s idea was that by leveraging its influence with the banks, it could compel the third-party payment processors to connect with CUP network system.

NP: Did the banks listen to CUP?

VW: No, they didn’t. The banks realized that if they obeyed CUP, it would mean paying CUP a network fee even on transactions using their own bankcards and processed through third-party payment processors. Consequently, CUP moved on to step two. In April, CUP had adopted the “Implementation Rules on Penalties and Rewards for Bank Cards Acquirers.” These Rules provide that a third party payment processor violates CUP’s rules if it engages in interbank settlements outside the CUP system. Under the rules CUP adopted in April, it will fine such a third party payment processor in an amount equal to the fees lost by CUP through the processor’s circumventing its system.

NP: Does step two have any some teeth?

VW: Actually, no. The rules came out in April. In July, the PBOC released its “Administrative Rules for Bankcard Acquiring.” Article 26 of the PBOC rules provides that an acquirer can route transaction information directly to the card issuing bank, provided it has entered into a cooperation agreement with the card issuing bank and the card issuing bank does not breach its contracts with the relevant card network. This endorsement of direct-connect deals was a big change in the final version of the PBOC rules versus the draft rules.

NP: What was CUP’s next move?

VW: The CUP Board met on July 25 and considered a resolution entitled “Proposed Resolution to Further Standardize CUP Cards Transactions with Non-Financial Institution Payment Processors and Safeguard the Rights and Interests of the Member Banks and CUP.” In the proposed resolution, CUP laid out a timetable aimed at forcing the third-party payment processors to connect with CUP’s system:

(1) Starting this month, all member banks should stop opening new CUP card connection portals with third party payment processors and should not add new CUP card business, such as wire transfers;

(2) By year-end, commercial banks should disconnect the offline transaction processing channels with third party payment processors – which would force them to directly or indirectly connect with CUP’s network system; and

(3) By July 1, 2014, third party payment processors should connect with CUP’s network system for their online CUP card transactions, and commercial banks should disconnect the online transaction processing channel with third party payment processors.

NP: This is a harsh schedule-it seems as though CUP feels pretty strongly about getting the third party processors to hook up to it, doesn’t it?

VW: Yes, but, so far, there’s no news — or even rumors — that such a proposed resolution is going to be approved. On the contrary, it’s unlikely that the proposed resolution will be approved because of bank opposition. Remember that CUP is also competing with the banks for fees.

NP: CUP is a card network, like Visa and MasterCard. What’s the problem with a card network requesting banks and payment processors to process CUP cards on the CUP network?

VW: A network should indeed have the right to manage its network and set rules for the network members, but, remember, two things make CUP unique. First, CUP was originally established with government support as a non-profit monopoly for RMB card processing. But now CUP is a stock company, and it should act like a market participant, not a monopoly or agency. It shouldn’t be trying to dictate to its members or third-party processors.

Second, CUP has gone into direct competition with its members in the payment processing business. It has a subsidiary that is a licensed third party payment processor. You don’t see Visa going into direct competition with Paymentech, right?

NP: The payment processing market is a highly dynamic and fast growing market with lots of innovation, but still, there should be some limits. Where do we go from here?

VW: It’s too early to predict how the dispute will get resolved. But I feel that it’s better to have a dispute and open discussion, than to try to settle everything behind closed doors among a few senior executives and regulators. Only by having a public conversation can our payments market mature, and can its participants learn to temper their aspirations and behavior.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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